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This week saw the dramatic arrest and criminal indictment of Bill Huang, the former director of private hedge fund Archegos Capital Management. You may remember that Archegos blew up last March. The banks that lent it money for huge leveraged deals ended up losing $10 billion.
There’s a great debate to have about whether what Hwang did was a complete fraud, but I wouldn’t bother trying to outsmart Matt Levine on this front. Instead, I want to focus on the financial mechanisms of what Archegos was about to do, and why it is so important for cryptocurrency holders or traders to understand them.
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The bottom line is simple: Archegos borrowed a lot of money and used it to buy very large amounts of about 10 different stocks. That purchase in itself helped push the shares higher, giving Archegos dividends on paper that they could use to borrow more money – which I then used to buy the same few shares, pushing them even higher. The leverage game produced amazing results for some time: Hwang reportedly launched Archegos with just $200 million in 2013, but by its peak, the fund’s paper value topped $30 billion, a 140% return in eight years.
But it was a tactic with a limited shelf life. Archegos has accumulated over time completely ridiculous positions on several major stocks. According to the US Securities and Exchange Commission (SEC), Archegos owns up to 45% of the outstanding shares in Tencent and more than 50% of the shares of ViacomCBS (now Paramount Global). A pillar of the fraud case against Hwang is that he lied to banks about these levels when borrowing money. And the way things have turned out shows why banks don’t often or willingly lend with that kind of focus.
ViacomCBS was the pin that blew the Archegos bubble. The stock ranged from about $35 in January of 2021 to nearly $95 by March. I would expect, but it seems very plausible that the aggressive purchase of Archegos (read: alleged market manipulation) contributed to the crazy scramble that spurred the sale of new shares. Either way, nearly tripling your money is a good thing!
Except when it isn’t. The increase in operating spurred ViacomCBS managers to issue new shares, which in turn led to a contraction in the stock, which is down 30% in three days. With high levels of concentration and leverage, that 30% drop in a single stock ended up being enough to earn Archegos the world’s worst marginal call. With the paper value of its holdings dropping against outstanding loan commitments, Archegos was forced to liquidate – and eventually nukes the entire fund.
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But – and this is the really important part – There is still enough to repay the lenders.
Archegos shows what can happen to any number of crypto assets that are leveraged or backed in certain ways. The key term here is the exit of liquidity, and one takeaway is the risk of support or concentrated holdings in a few assets that could suddenly collapse in a liquidity crunch. In many cryptocurrency ecosystems, token holders are in the same position as the banks that lent Hwang: they risk falling into a token trap as it burns around them.
Last week I wrote about the possibility of a relaxation of the terraUSD (UST) stablecoin, which by the most generous interpretation is currently “backed” by a single asset, LUNA. The Luna team is working on diversifying this support to avoid the kind of concentrated risk hitting Hwang, but their current target is to reach three different assets by adding BTC and AVAX. Huang ended up being very fragile while holding nearly 10 large positions.
Another suggestive similarity here is the valuation mechanisms of cryptocurrencies in general, particularly when it comes to founders’ rewards, pre-miners, or other large pools of tokens held in relatively stable blocks. As many have pointed out, the measure of “market value” that many tokens promote is largely rendered meaningless by these massive allocations, which basically don’t exist in the market, and often haven’t. The same may be discussed for lockouts in some lending and betting protocols.
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These large blocks of uncirculated tokens inflate the total market capitalization of coins in a way that is very similar to the way Archegos has inflated its portfolio. Although the effects of pre-mining and storage are subtler, both create a misleading perception of the scarcity or demand for the asset. And both, although for different reasons, can lead to retail investors stealing their faces: If you saw ViacomCBS surged in March of last year and bought, you ended up going Bill Huang out of cash as he burned it from $97 to $48. In just seven days. Perhaps you can have a very therapeutic conversation with a SafeMoon holder.
And let’s not forget the poor banks (God forbid!). For example, Credit Suisse bears the bulk of Archegos Bank’s losses, eating $4.7 billion. That, in turn, was enough to slash Credit Suisse’s stock price by about 18% within days after Archegos’ fall. The bank was already in turmoil before this incident, and its stock hasn’t recovered in the year since.
Bill Huang may be a criminal, or he may simply have been playing Wall Street by an unwritten but accepted set of rules – after all, in this day and age, cheating and lying are practically qualifiers to work in high finance. Crypto has a clear advantage of transparency – Hwang could not have done the same amount of damage if he had not dimmed his levels of focus and leverage. In most cases, similar behavior by Layer 1 or another protocol may be more evident. The question is whether merchants and investors are paying enough attention to what’s on the blockchain to avoid restarting Archegos, in the form of crypto.